Ollie's Bargain Outlet Holdings, Inc. Q4 FY2022 Earnings Call

Welcome to Ollie's Bargain Outlet Conference Call to discuss the financial results for the Fourth Quarter and Full Year 2022. Currently, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and interactive instructions will follow at that time. Please be advised that this call is being recorded and the reproduction of this call in whole or in part is not permitted without expressed written authorization of Ollie's. Joining us on today's call from Ollie's management are John Swygert, President and Chief Executive Officer; and Eric van der Valk, Executive Vice President and Chief Operating Officer; and Rob Helm, Senior Vice President and Chief Financial Officer. I will now turn the conference call over to your host today Lyn Walther with ICR. Please go ahead.

Thank you. Good morning, and welcome to Ollie's fourth quarter conference call. A press release covering the company's financial results was issued this morning and a copy of that release can be found in the Investor Relations section of the company's website. I want to remind everyone that management's remarks on this call may contain forward-looking statements, including, but not limited to predictions, expectations or estimates, and that actual results could differ materially from those mentioned on today's call. Any such items, including with respect to our performance, should be considered forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. You should not place undue reliance on these forward-looking statements, which speak only as of today and we undertake no obligation to update or revise them for any new information or future events. Factors that might affect future results may not be in our control and are discussed in our SEC filings. We encourage you to review these filings, including our Annual Report on Form 10-K and Quarterly Reports on Form 10-Q, as well as our earnings release issued earlier today for a more detailed description of these factors. We will be referring to certain non-GAAP financial measures on today's call that we believe may be important for investors to assess our operating performance. Reconciliation of those most closely comparable GAAP financial measures to the non-GAAP financial measures are included in our earnings release. And with that, I will turn the call over to John.

Thanks, Lyn, and good morning, everyone. Thank you for joining our call today. We were pleased with our performance during the fourth quarter, which reflected an improvement in our comparable store sales as we moved through each month of the quarter. We executed well despite the highly promotional environment and generated a 3% increase in comparable store sales ahead of our expectations. Our strong comparable store sales combined with our new store growth drove a 9.7% increase in total sales for the quarter. We are encouraged by the transaction trends we experienced in the fourth quarter as customers responded to our incredible deals. Our strongest categories were food, candy, health and beauty, seasonal, and automotive, while we experienced some softness in discretionary categories such as toys and bed and bath. Our gross margin improved 110 basis points during the fourth quarter to 37.6% compared to 36.5% last year, driven by lower supply chain costs due to increased productivity and reduced transportation expenses. Merchandise margin was flat to last year despite increased promotional markdowns and an uptick in shrink. We were pleased with our ability to navigate these challenges and deliver an improved gross margin compared to last year. On the bottom line, we delivered a 19.5% increase in adjusted net income driven by increased comparable store sales, improved gross margin, and disciplined expense control. As deal flow continues to be strong, we are selectively investing in price to motivate consumers given the competitive environment while maintaining our gross margin targets. As consumers need to save money, the strength of our value proposition is resonating and we have seen an acceleration in our business over the past few months. We believe we are well-positioned to thrive in the current environment and our customers are responding to the tremendous values in our stores. Our deal pipeline is robust and we are excited about the opportunities ahead of us. In terms of marketing, we are focused on developing greater brand awareness, particularly in newer markets, and see opportunities to strengthen communication of our deals to be more clear and impactful. We continue to work to elevate our messaging and optimize the balance between print and digital media to drive traffic. We are pleased with the results of our influencer program and we'll make this part of our marketing mix going forward. Ollie's Army continues to grow steadily and remains a key driver of our sales, accounting for almost 80% of our sales in the fourth quarter. The Army grew 4.8% over the prior year, ending the period with over 13.2 million active members. We were pleased with Ollie's Army Night, an event where we offer exclusive deals and discounts to our most loyal customers. We continue to build our civilian database comprised of non-Ollie's Army shoppers which is being used for email, messaging, and other digital marketing initiatives. We remain confident in our business model and are focused on three strategic pillars: offering compelling deals, expanding operating margins, and growing our store base. I will discuss the deal flow and then turn the call over to Eric to review expanding our operating margins and growing our store base. The closeout market remains extremely strong. The disruptions in the market today have led to one of the most robust closeout environments we have seen in a long time. With last year's supply chain challenges, we are seeing incredible opportunities for our customers from many different suppliers. Our longstanding vendor relationships make us the preferred first call for the best deals on some of the best brands in the market. New vendors are reaching out to us each and every day because of our scale and how easy we are to work with. We have an experienced merchant team with the know-how to get the best deals for our customers. We are focused on adding more newness and excitement to the product offerings, which creates a sense of urgency and drives shoppers to our stores. While we are incredibly excited about the opportunities in front of us, we recognize the pressures consumers are facing today and will remain disciplined and selective in our buys, which we believe will position us to deliver both good stuff cheap to our customers and strong margins to our shareholders. I'm now going to turn the call over to Eric to discuss the other strategic pillars.

Thanks, John, and good morning, everyone. Our second strategic pillar is to expand operating margins. We made great progress toward this goal in the back half of fiscal 2022, but know there is more work ahead of us. We see a clear path to expand operating margins over time by leveraging supply chain enhancements while retaining the gains we have made in merchandise margin, increasing leverage through growth in scale, and maintaining our strong expense management discipline. Our approach to import freight procurement will continue to benefit us and we are seeing transportation costs in the market continue to ease. Our third priority is to grow our store base. We opened five stores in the fourth quarter, ending the year with 468 stores in 29 states compared to 431 stores last year. We are planning to open 45 stores in fiscal 2023, slightly below our long-term target of 50 stores to 55 stores annually, due to the longer lead times for permitting and construction we have experienced. However, we remain confident in our ability to open at least 1,050 stores and plan on returning to our normal store opening cadence for fiscal 2024. To improve our customer shopping experience in our existing stores, we began testing a store remodel program last year, and we are pleased with the results of the first 21 stores. We made changes to our store layouts such as improving category flow and sight lines, updating race tracks, and adding checkout queues. Our initial results give us the confidence to continue to expand this program and we plan to remodel an additional 30 to 40 stores in fiscal 2023. We are benefiting from the enhancements we have made to our supply chain and we will continue to make additional investments to support our store growth. The expansion of our Pennsylvania distribution center is well underway and we expect it to be completed by the second quarter of 2023. We plan to break ground soon on our fourth distribution center in Illinois, which we expect to open in the second quarter of fiscal 2024. When the network expansions are completed, we will have the capacity to support over 700 stores. We believe that the investments we are making will position us to deliver consistent long-term growth. Before I hand it over to Rob, I'd like to thank our almost 11,000 teammates for their hard work and commitment to making Ollie's a special experience for both our associates and customers. Rob will now take you through our financial results and our outlook for fiscal 2023 in more detail.

Thanks, Eric, and good morning, everyone. I'm going to start with a review of our fourth quarter performance, then I'll provide our guidance for fiscal 2023. Starting with the fourth quarter, we are pleased to deliver strong results above our expectations. Net sales totaled $550 million, an increase of 9.7% from the prior year. Comparable store sales increased 3% in the quarter compared to last year, driven primarily by an increase in transactions. During the quarter, we opened five new stores, ending the quarter with 468 stores in 29 states and an 8.6% increase in store count year-over-year, and while early, we are pleased with the performance in these new stores. Since the end of the fourth quarter, we've opened an additional eight stores and closed one store location. Gross profit margin improved 110 basis points to 37.6% compared to 36.5% in Q4 last year due to lower supply chain costs. Merchandise margins for Q4 were flat to last year despite the highly promotional environment. Similar to other retailers, we did experience an uptick in shrink during the quarter. SG&A expenses as a percentage of net sales were flat to last year at 23.8%. Operating income totaled $68 million for the quarter, an increase of 17.8% compared to last year. Operating margin increased 80 basis points to 12.3%, driven by the lower supply chain costs and new store unit growth, partially offset by higher selling expenses. Adjusted net income increased 19.5% to $52 million and adjusted earnings per share was $0.84 compared to $0.69 last year. Adjusted EBITDA increased 16.7% to $77 million and adjusted EBITDA margin increased 80 basis points to 14% for the quarter. Turning to the balance sheet. Our balance sheet cash position remained strong with $271 million between cash on hand and short-term investments and no outstanding borrowings on our revolving credit facility at year-end. Inventory increased 1% to $471 million in the quarter compared with $467 million a year ago. We are pleased with our inventory position entering 2023 and are starting to see the benefits of lower freight costs and the normalization of lead times in our in-transit inventory, which combined represented a total of $35 million. Adjusting for these items, our remaining inventory increased approximately 12% in line with our expectations. Capital expenditures totaled $13 million primarily for new and existing stores and the expansion of the Pennsylvania distribution center. This compares with $5 million in the prior year. During the quarter, we invested $12 million to repurchase shares of our common stock. We repurchased $42 million during the year and have $138 million remaining on our share repurchase program authorization. We remain committed to returning capital to our investors through share repurchases while balancing our strategic growth opportunities and working capital needs. Turning to our outlook for fiscal 2023. While we are confident in our trends and our current momentum and believe that we are well-positioned, we are planning our business more in line with our long-term annual target of 1% to 2% comp store sales growth, coupled with the new unit growth of 45 stores. With that framework in place, for the full year, which includes a 53rd week, we expect total net sales of $2.036 billion to $2.058 billion; comp store sales of 1% to 2%; the opening of 45 new stores, less one closure; gross margin in the range of 39.1% to 39.3%; operating income of $205 million to $213 million; adjusted net income of $156 million to $263 million; and adjusted earnings per share of $2.49 to $2.58, both of which exclude excess tax benefits related to stock-based compensation. An annual effective tax rate of 25%, which excludes the tax benefits related to stock-based compensation and diluted weighted average shares outstanding of approximately $63 million. We are planning for capital expenditures in the range of $125 million with approximately $75 million earmarked for the construction of our fourth distribution center and the expansion of our Pennsylvania distribution center. The remaining $50 million will be for new stores, existing store remodels and maintenance capital, IT investments, and general corporate projects. I also wanted to take a moment to give some additional color on how we're thinking about the quarterly flow during the course of the year. As I mentioned earlier, we are seeing positive momentum in our business right now and we expect to deliver Q1 comps at the high end of our annual guidance range. Moving ahead to Q2, we are planning comps to the midpoint of our annual guidance range. For Q3, we anticipate comp sales to be flat to last year due to a strategic change in flyer timing between Q3 and Q4. As a result, we would expect Q4 comps to be slightly above the high end of our annual guidance range. We expect preopening expenses to be approximately $15 million. The majority of our new store openings this year is more weighted to the back half of 2023. Approximately 40% of our openings will be in the first half of the year and 60% will be in the second half. From a gross margin perspective, we're planning for a significant improvement in the first half of the year as we lap the impact of the elevated supply chain costs in 2022. As we begin to anniversary more normalized supply chain costs in the back half of the year, we expect to deliver modest year-over-year margin expansion. We expect depreciation and amortization expense to be approximately $35 million including approximately $8 million that runs through the cost of goods sold and we anticipate net interest income in the range of $5 million. I will now turn the call over to John for his closing remarks.

In closing, I'd like to thank the entire Ollie's team for their incredible hard work and dedication each and every day. We are well positioned today as ever for growth and we are positioned to deliver good stuff cheap to our customers. We feel very good about the current trends and momentum in our business from deal flow, to expense control, to new stores and look forward to updating you on the progress at our first quarter call. As we say, we are Ollie's. We will now take your questions.

Our first question comes from Peter Keith from Piper Sandler. Please go ahead with your question.

Hey, good morning, everyone. So, John, you had mentioned that your value proposition is really starting to resonate with your customers. If you look back on 2022, it did seem like the comps were a little bit disappointing. Do you think that the markdown and clearance environment across retail maybe diluted your value proposition and now that we're pivoting to 2023 that the value proposition has a better time to shine?

I believe that's certainly a factor. The inflation I've mentioned previously, along with the timing of its impact on consumer behavior, played a role. The combination of inflation and timing, along with how aggressive other retailers were with promotions last year, affected our value proposition. However, our deals are strong, and customers are responding positively. We’re optimistic and believe that 2023 is positioned for us to excel, and I think it will unfold as we expect.

Okay, great. And just another question I had just on the various puts and takes around fiscal stimulus. So there's been a pretty big increase for social security recipients, which is snap cuts. Any observation on how those puts and takes might be impacting your sales or traffic trends?

Peter, it's Eric. We are seeing that the strongest growth in terms of each segment is coming from our older and more mature customers aged 61 and up. Potential influences could be the adjustment to social security benefits depending on what it means in terms of discretionary income for that customer base. Also could be that customers are feeling more safe to shop. So we're seeing the customer engage more frequently with us than they have over the last two years. And then we're not sure what tax refunds may mean to that group and that's to be determined.

Yes, Peter, regarding the SNAP benefits, there is some relevance, but we are not primarily a low-income destination. We do not accept EBT and we don’t offer perishables in our stores, which are not part of our core customer base. Therefore, while there is some impact, it is not significant enough to cause us major concern.

Okay. Sounds good. Thank you and good luck.

Thanks, Peter.

Thank you. One moment for our next question. And our next question comes from the line of Eric Cohen from Gordon Haskett. Your question, please.

Hi, thanks, and great quarter. You guys have talked about the really strong closeout environment for several quarters now, and it sounds like it's still growing really strong, and typically pre-pandemic you guys were doing a 3% to 4% comp pretty consistently. So given how strong the environment you've been talking about is, is the 1%, 2% just conservatism, or is there anything structurally different about the business today?

Yes, I believe we always plan with a 1% to 2% comparable sales growth in mind, even during the pandemic. Our infrastructure is built around that range. We find no reason to aim for a 3% or 4% growth only to risk disappointing the market. There remains a significant level of uncertainty, so being cautious is the sensible approach for us in managing the business. As we've mentioned before, we will not shut the registers; if customers are present, we will work to attract them into our stores to enhance profitability for our shareholders. This is our plan moving forward, and if sales turn out to be stronger than expected, we will ensure that earnings are delivered to our shareholders.

Good. And it's great to hear you guys are now exploring the store remodel program.

From a sales standpoint, we do like the initial indication of positive results in sales. Not ready to commit to a specific comp lift. But we do believe the ROI is more or less in line with the return we would get on a new store, which is, call it, one to two years.

Great. Thanks a lot.

Thanks, Eric.

Thank you. One moment for our next question. Our next question comes from the line of Jeremy Hamblin from Craig-Hallum. Your question, please.

Thanks, and congratulations on the momentum and strong results. I wanted to start with the impact of the distribution centers. In terms of the potential impact to results or margins, both in 2023 and 2024, and get a sense, Eric, on what you think what the potential drag might be in those years, but then also, when we get out in the back end of this, you noted that it's going to allow you to support 700 locations or so, but wanted to get a sense for potential impact of reduced stem miles and so forth, the type of margin benefit you might be getting from that?

Sure. I'll answer more of the operational piece of the question and Rob will take the financial piece, Jeremy. We do believe in terms of throughput and overall capacity that we're very well positioned for the growth in our business in 2023 and beyond, especially with the opening of the Illinois building in 2024. 700 stores is probably a little bit conservative in terms of what we could support going forward once all of these investments have been made. So, I'll leave the financial question to Rob.

From a 2023 perspective, the York, Pennsylvania expansion, we really have no dilution to margins for this year because it's an existing building that we're already in. The Princeton, Illinois building in 2024 would have a 10 basis point to 20 basis point drag on our second half gross margins at that time.

Okay. What are you thinking regarding any potential reduction in transportation costs once we implement these changes to support store-based operations, and what long-term benefits do you expect from it?

Jeremy, obviously, it's all kind of blended in there. Obviously, we need to open up that fourth distribution center in order to service the stores. That's just a strict volume that comes through the boxes and, obviously, there is a freight savings, but basically our impact that we give to you is net-net, that's the net impact of the margin and it's probably, call it, 10 basis points to 20 basis points on the back half and that's including the freight savings offset by the incremental cost of the four walls that we built.

Got it. Understood. And then I wanted to ask a question just in terms of the store openings, right? So we know that there are still some longer lead times here both on permitting construction and materials so forth. In terms of sitting here in March of 2023, how are you thinking about the potential to get back to that targeted range of 50 to 55 in 2024?

We are feeling very confident about 2024. We believe that the conditions in the commercial real estate market are very favorable for that year. There is some disruption happening in retail, as many are aware, with certain retailers facing challenges, stress, and even bankruptcy filings, which usually works to our advantage. It typically takes one to two years for locations to become available, referred to as second generation sites, which fit into our financial model. Therefore, projecting one to two years ahead suggests a very positive real estate environment for 2024.

Yes. One thing to add, Jeremy, the one thing that does help us get a little more comfort level as well with the opening of the fourth DC gives us additional states for our real estate folks to go and visit potential opportunities. So with that, plus the backfills, it makes a little bit stronger opportunity there.

Okay, great. Thanks for the color, guys.

Thank you.

Thanks, Jeremy.

Thank you. One moment for our next question. And our next question comes from the line of Bradley Thomas from KeyBanc. Your question, please.

Hi, good morning. Thanks for taking my question and a nice end to the year. I wanted to first just ask about the outlook for gross margin. Obviously, a backdrop for many retailers dealing with some mixed headwinds in a more promotional environment. And so, I was hoping you could just talk a little more about the kind of the building blocks of the gross margin expansion for this year? And then, as we think about the timing through the year, it looks like maybe you need to be above the full-year guidance range in the first half given the way you've kind of talked about the shape of the year. So just any more color on how to think about the timing of this improvement because it's such a big increase you're looking for here this year?

I'll address the merchandise margin aspect and then hand it over to Rob for the rest. Overall, the merchandise margin is strong due to robust deal flow. Our merchants are selective, and we see opportunities that will help improve our merchandise margins to balance the supply chain costs. We are projecting margins between 39.1% and 39.3% for the full year, which we believe is attainable based on our supply chain projections, and we don't consider it a significant stretch compared to last year.

From a supply chain perspective, we are planning for pretty considerable improvement. When we lap the impact of the first half, which was roughly, say, 750 basis points for Q2 last year and roughly 400 basis points for Q1. That impact for the year totals, say, 300 basis points in gross margin improvement and that's pretty much how we get to our guidance of 39.1% to 39.3%.

Got you. Okay. And if I got a follow-up just on your commentary about the first quarter, I believe you said that if that comps is coming at the high end of the full-year range, which should be 2%. I think you also said that comps had accelerated thus far in 1Q that could be above 2%. So just trying to rectify those two comments. Any reason that you think we might be in the 2% range rather than perhaps something a bit better given the momentum you have so far?

It's simply a matter of conservatism and our current situation.

Wonderful. Appreciate all the detail.

Yes, thank you.

Thank you. One moment for our next question. And our next question comes from the line of Jason Haas from Bank of America. Your question, please.

Hey, it's Jason Haas. Thanks for taking my questions. So, I had a quick one on gross margin. I think for 4Q, it came in a little bit light. I think maybe 70 bps or so versus what was implied by your guidance. Did you see that that was driven by?

From the fourth quarter perspective, we're pleased with our gross margin performance. It was a heavily promotional environment, as all of you are aware. Markdowns came in higher as well as there was an uptick in shrink, which has also been widely reported.

Got it. That's helpful. And then, as I look at the guidance for the upcoming year, it seems to imply higher new store productivity. It's a little difficult just to tell because I know you have the 53rd week, but is there anything that would be driving higher new store productivity this year?

So the new store productivity has been a little volatile over the last couple of years with the COVID lockdowns and whatnot. We've seen a steady trend of recovery and improvement and our guidance implies the continued improvement to get back to historical new store productivity levels.

Yes, Jason. The one thing, when you adjust for the 53rd week, the new store productivity levels are almost back to normal historical. They're not really elevated any more than that. The 53rd week does create a little bit of confusion when you look at it, though.

Got it. Have you estimated how much sales the 53rd week should contribute?

Yeah, it's a relatively low volume weight. I would call it in the range of, say, $30 million.

Okay. All right. Thank you.

Thanks, Jason.

Thank you. One moment for our next question. And our next question comes from the line of Kate McShane from Goldman Sachs. Your question please.

Hi, thanks for taking our question. I know you mentioned earlier some strength that you're seeing from maybe some of the fixed income customers in that shop Ollie, but we wondered if you had seen any change in trend with regards to the higher income customers? And if so, is it trading down across the entire store and more focused on certain categories?

Hi Kate, it's Eric. Yes, we are observing that higher income consumers continue to trade down, which has been a trend for several quarters now, showing similar rates in Q4 compared to Q3. We are also noticing that the fixed income consumer is beginning to stabilize after previously experiencing a trade-out effect over the past quarters. It's now closer to flat in comparison to historical periods. Unfortunately, we don't have the current data to determine which specific categories they are gravitating towards, so I can't answer that question.

Okay. And our second question is just with regards to the guidance, again, the comp of 1% to 2%, which you said is being conservative. How are you incorporating the thoughts of any shifting share of wallet that might still take place during 2023 from goods to services?

Yes, Kate. We don't really look at the shifting of the wallet. We look at the deal flow and the deals we're able to secure for our customers to motivate the consumer to come in the store and shop. That being the closeout model, it's a little bit different than most retailers. So the deal flow kind of gives us the indication of our strength and confidence of the customers coming to us and needing what we're offering to them.

Thank you.

Thank you.

Thank you. One moment for our next question. And our next question comes from the line of Edward Kelly from Wells Fargo. Your question please.

Yeah. Hi guys. Good morning.

Good morning, Ed.

I just wanted to start on just a follow-up, I guess, on the gross margin. You talked about a bit more modest improvement in the back half of the year, but I think you should have some decent freight coming in as well. Like I thought you really got hit on spot in Q4 of 2021 and I think you contracted for a lot of last year. So maybe just a little bit more color on back half gross margin and maybe why you wouldn't see a bit more improvement? And then John, as you think about like the 40% number, what's holding you back from getting there in 2023 and is it something that's possible things fall your way?

I'll start with the last question and then Rob can address the other parts. What's holding us back is the high freight and supply chain costs that are still included in our figures, and they haven't returned to pre-COVID levels yet. However, if the current deal flow remains strong, there's a chance for improvement. We're also experiencing a shift in product mix, with lower margin consumable products being sold more frequently. That said, the progress we've made in our margins from 39.1% to 39.3% is encouraging, and if we can perform even better, we will. I believe we have a strong likelihood of reaching a 40% gross margin in 2024.

Yeah. To John's point on the back half, our supply chain cost averaged in the range of 11% of sales. We would expect that should transportation continue to ease, and we will do better than that, but we don't have a crystal ball in terms of what's going to happen in the transportation market, and we wanted to remain conservative with our guidance.

Okay. One more quick question regarding labor. We are noticing significant investment in labor across retail. If you consider your average hourly wage, it seems to be on the lower side, but I'm curious about your thoughts on that. What are your views on wage rates, labor hours, and whether there's a need for any investment in that area?

Yeah, this is Eric. I'll take the question. We have invested pretty significantly over the last two years in wages. We do continue to experience some wage pressure, and we continue to invest. It's really market by market; we're reacting to ensuring that we retain and attract talent in our stores. Cash flow is pretty decent at this point. So we're feeling pretty good about that across both stores and distribution centers. So we continue to invest to ensure that we have our labor pool pretty stable.

Okay, thank you.

Thanks, Ed.

Thanks, Ed.

Thank you. One moment for our next question. And our next question comes from the line of Mark Carden from UBS. Your question please.

Good morning. Thanks so much for taking the question. So to start on deal flow, you noted it's strong overall. At this stage, do you think you have mostly passed through the biggest wins that emerged from some of the unusual challenges that your competitors faced? Would you still expect for a few more quarters of that type of lifts related to these? Or is it more just normalized solid deal flow at this point?

It's difficult to say for sure, but I can share that merchants are experiencing significant momentum. There are still substantial opportunities out there that haven't been fully tapped into. I believe this trend will persist for perhaps another two quarters. While deal flow is generally strong, currently it is exceptionally robust, and merchants are being very selective in their purchases. I think this will contribute positively to our business.

Okay, great. And then just a quick follow-up. As you think about your new store openings in the year ahead, how are you thinking about the balance between new markets and existing markets?

Yes. Defining new markets and existing markets for us is a bit challenging because we have many states that are significantly underpenetrated. Therefore, we still consider those as newer markets. However, looking at it overall, I would estimate that about 40% to 50% can be categorized as new, while 50% to 60% would be considered existing.

Great. Thanks so much and good luck.

Thank you, Mark.

Thank you. One moment for our next question. And our next question comes from the line of Simeon Gutman from Morgan Stanley. Your question please.

Good morning, everyone. First, a two-part question. It's a follow-up to gross margins. So you mentioned there were higher promotions in the fourth quarter. Is the bridge to 2023, I think it sounds like it's mostly supply chain and you're embedding a similar level of promotions. And then the connected part of this question is, is there a comp lift that you could estimate that helps the business so that we know how to think about modeling the back half of next year when maybe there's fewer promotions?

I can address that question, it's Rob. You're right. Most of our gross margin improvement is linked to supply chain costs and the relief we experienced in the first half of 2022. Regarding comparisons, we used to leverage our expense base around 1% to 2%, but with the increased investment in wages that Eric mentioned earlier, it’s likely closer to 2% to maintain leverage on our expenses.

Okay. In a related follow-up regarding the strong closeout environment, are there different product categories emerging, and are customers responding to deeper discounts? It seems some of the closeouts involved over-consumed categories. Is that situation evolving, and is the competitive landscape shifting?

I would say that things are shifting a bit, but there's still a wide range of closeout opportunities available in the market across various categories like HBA, housewares, clothing, flooring, lawn and garden, and auto. We haven't pinpointed one specific area that's being fully tapped. However, we have observed that food, candy, and HBA are significant drivers this quarter, and consumables are definitely becoming more prominent. When customers visit our stores, they notice the consumables and often make additional purchases of non-consumable items. The deals really resonate with shoppers once they see the value we offer. This trend is strengthening, and our merchants are being very selective in identifying what’s available in the market today.

Thanks, John.

Thanks, Simeon.

Thank you. One moment for our next question. And our next question comes from the line of Matthew Boss from JPMorgan. Your question please.

Great, thanks. So John, maybe could you elaborate on some of the shopping patterns that you're seeing from your core customer? Is there a correlation maybe to look back at the financial crisis? I know you've talked about the stock market and some of the different pressure points then; trying to think of applying it to today. And then, Eric, on this year's guide, so it implies a geometric stack of about 1% for the year. How do we triangulate that multiyear stack trend to the pre-pandemic comp algorithm?

Yeah, Matt, regarding the overall shopping patterns, we won't delve too deeply into that data at the moment, but it's evident that our offerings are appealing to consumers, which is reflected in the comparable sales we achieved in Q4. Moving into Q1, we feel confident about what customers are purchasing and we're observing a positive impact from our consumables. Beyond that, I won't share too many specifics.

Hi. And this is Rob. From a geometric stack perspective, we've talked about the three-year business last year. The business, it's a different time from what it was in 2019. So we're not really going to speak to it from this point forward. We did see a small acceleration though from Q3 to Q4 in terms of a three-year geo.

Great. And then maybe just on the expense front. For 2023 and then thinking forward, what's the right level of comp growth needed to leverage SG&A? And how best to think about the 25% SG&A rate pre-pandemic? What's the right level in the model multiyear from here?

I believe we are at around 26.8% for this year, and 26.9% regarding SG&A. The 25% benchmark has been impacted by the rising costs we have experienced since 2019 and during the pandemic, which has altered our overall structure. We need to increase comparable store sales to reduce that percentage from where it currently stands. If we achieve a 2% increase in comp sales, we might be able to lower it by 10 to 20 basis points on an annual basis, but not much more than that.

Yeah, Matt, this is Eric. I would just add that we continue to pursue productivity improvements in the business to offset some of the wage pressure we're experiencing, especially in stores. We still do have a list of initiatives that we're pursuing that will help to offset some of this wage pressure.

Great. Best of luck.

Thanks, Matt.

Thanks.

Thank you. One moment for our next question. And our next question comes from the line of Scot Ciccarelli from Truist. Your question, please. You might have your phone on mute. Scott, we're not hearing you at this moment. All right. We'll move on. One moment for our next question. Our next question comes from the line of Paul Lejuez from Citi. Your question, please.

Hi, everyone. This is Brandon Cheatham on for Paul. I was wondering if you could share your outlook on merchandise margin for the year. It sounds like there might be a little bit of pressure. I was wondering if you could break out like some of the puts and takes, what you're investing in price versus what might be driven by mix?

Yes, Brandon, the overall merchandise margin is essentially unchanged compared to last year, as Rob mentioned. There aren't really any significant factors impacting it. We are confident in our current position and believe we can achieve our goals.

Got you. And I was just wondering, could you quantify when you get to the end of this year, if you look at your freight costs, how much are those up compared to 2019 levels? Just trying to get a sense of what could be the benefit in 2024 or for the out year should freight completely normalize to pre-pandemic.

I think I said earlier in the call that our supply chain costs for 2022 on a full year basis came in the range of 13%. Our 2023 guide is more in the range of 10%. And we've said on past calls that supply chain costs range in the range of 7% to 8% pre-pandemic. So that gives you a quantification if we got all the way back to pre-pandemic levels. What the improvement would be? There's a small deleverage that we have relative to wage investments in the DC, but that's a relatively minor portion relative to the gap that I just referenced.

Got it. Okay. That makes sense. Last one from me. Does your new DC, does that potentially allow you to get product to stores quicker? And could that change how you approach the closeouts that you might purchase at various points in the season?

Brandon, it's Eric. No, our new DC, I mean, it's a matter of hours really, the difference between an existing DC and new DC to some of the stores that are friendly from a geographic standpoint to Illinois. So the difference of a 12-hour drive versus a six-hour drive doesn't make really any difference in terms of our ability to deliver units to the customer. Sure. Yes, a little different spin on the question. We are looking at all the options that are available to us that in terms of automation or semi-automation, we're in that process of making the selection of our material handling equipment now over the next 30 days to 60 days. So we're looking at it more from a financial standpoint and what is the return on the investment if we were to spend on automation, but also to reduce our reliance on human capital in general is a good thing considering it's been a risk for retailers, especially over the last several years. So we are considering. But to just connect that to your first question, I don't know that it's going to make any difference in our business from a top line standpoint. It's more about overall throughput and productivity that it would be about moving products faster through DC to a store. Again, it would come down to a matter of hours and not days. So I don't see those investments making a different top line.

Yeah. Paul, basically, the DC expansion is really built out to be able to reduce the stem miles we're driving and be able to continue to grow stores further and further apart and be able to service them.

Got it. Okay. Appreciate it. Good luck guys.

Thanks, Brandon.

Thank you. One moment. We have a question from Scot Ciccarelli from Truist. Your line is now open. We're still not hearing you. I'm not sure if you have a mute button.

Hey, good morning. This is Josh calling in for Scot Ciccarelli. With the strength you guys are seeing in consumables, do you have any plans to expand your offering there to meet the shifting demand trends from consumers?

Hi Josh, we don't have any plans to expand consumable offerings in the stores. We plan to continue managing inventory and restocking based on what customers are purchasing. Our model is quite straightforward. We maintain consumable levels around 22%, and we intend to stick to that. However, we are working to increase the turnover rate as sales continue to rise.

Yeah, Josh. Just to emphasize that point, we're not expanding the footprint of stores either. The inventory just turns faster.

Yeah. Okay, that's helpful. And then one other one on Ollie's Army. Are you guys seeing any notable shifts in behavior among the Army members versus non-members? And are there any new initiatives you're thinking about for 2022 to help drive memberships?

We're seeing, Josh, the behaviors of the consumers to be pretty similar in Q4 versus previous quarters. So we're very happy with the strength of the Army in general, delivering over 80% of our sales and the strength of the transaction of the Ollie's Army customer versus the non-Ollie's Army customer. Nothing of significance to report in terms of what we're doing with Ollie's Army with the civilians in our Ollie's Army, people that were able to identify, we're continuing to pursue ways to reach out to those consumers, both stimulate them and convert them to the Army. So we definitely are focused on continuing to convert and acquire customers into the Army.

Yeah. Okay, helpful color. Thanks, guys.

Thank you.

Thanks, Josh.

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to John Swygert for any further remarks.

Thank you for your support of Ollie's. We look forward to updating you on our results next quarter. Have a great day.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.